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Tag: GDP

The size of China’s government is enormous. By 2007 China’s fiscal revenues had reached 5.1 trillion yuan ($770 billion), which accounted for 21 percent of GDP and was equivalent to 370 million urban residents’ annual disposable income — or the annual net income of 1.23 billion farmers.

Imperial China’s Fiscal Revenue

How does China’s fiscal revenue under Communist Party rule compare with the era under imperial rule? In 1766, during the mid-Qianlong era, the government’s fiscal revenue was 49.37 million taels of silver.

The Dutch East India Company conducted detailed investigations around 1760 on income and consumption of people in Beijing and Guangzhou. According to historical archives, the annual income of an ordinary Beijing citizen was about 24 taels. Therefore, 49.37 million taels of silver was equivalent to 2.05 million ordinary Beijing citizens’ annual income. The income of just 2.05 million Beijing citizens was sufficient to support the entire Qianlong government. Obviously, it was a small government.

Of course, some people might say that we cannot compare any country’s government revenues and spending with a period of the past, because those were traditional agricultural economies, and government revenues were therefore low. Modern economies, however, are complex and depend on various kinds of government assistance. This reasoning makes a certain amount of sense. So, let’s use a different example.

United States’ Fiscal Revenue

Let’s use the United States, a modern country, as comparison with today’s China. The U.S. financial securities markets, intellectual property sector, and private enterprises are the most developed in the world. In addition, it also plays the role as world police. Therefore, its government spending would not be lower than any other country’s.

In 2007 the U.S. federal government’s fiscal revenue was $2.4 trillion, or 18 percent of GDP, and was equivalent to 85 million average American citizens’ annual disposable income. That is to say, in order to support the U.S. government’s spending, it took 85 million Americans’ disposable income. This is far lower than the 370 million Chinese urban residents required to support the Chinese government in 2007.

China has 540 million urban residents, and 800 million farmers. Their total disposable income last year was 10.7 trillion yuan ($1.62 trillion). The Chinese government’s fiscal revenue was 50 percent of Chinese citizens’ total disposable income.

By contrast, total disposable income in the United States was $8.4 trillion. The $2.4 trillion government fiscal revenue was equal to one quarter of U.S. citizens’ disposable income.

Thus, the Chinese government is much larger than the U.S. government in terms of fiscal budget.

Private Wealth Structure Comparison

Chinese citizens do own wealth, including real estate, corporate equity, financial securities, bank deposits, and so on. But these citizens are mainly urban residents. Chinese farmers do not own land, nor do they have much savings. They have little wealth.

According to a National Development and Reform Commission (NDRC) estimate, by the end of 2005, the total asset value of Chinese urban residents was 20.6 trillion yuan ($3.11 trillion). If adding 15 percent to adjust for inflation, it would have been 27.6 trillion yuan ($4.17 trillion) by the end of 2015, less than one third of the 88 trillion yuan worth of state-owned assets and state-owned land.

The total of China’s private and state-owned assets was 115.6 trillion yuan ($17.5 trillion), equivalent to 4.7 times of GDP. In contrast, the U.S. government basically does not own income producing assets. It only holds a small amount of land. By the end of 2007, total private assets in the United States were $73 trillion, 5.4 times of GDP and slightly higher than China’s ratio of total assets versus GDP.

Although the ratio of total assets and GDP of the two countries is roughly the same, wealth distribution between the people and the government is completely different. In China, more than 76 percent of assets are owned by the state, with people owning less than a quarter. In the United States, assets are basically in the hands of the people.

Of China’s 115.6 trillion yuan of wealth in 2007, only 27.6 trillion ($4.17 trillion) belonged to people, the remaining 88 trillion yuan ($13.3 trillion) was owned by the state. If in 2008, China’s asset value and GDP increased by 10 percent, then private citizens earned 2.76 trillion yuan, and the government earned 8.8 trillion yuan. The government’s share of asset appreciation from economic growth was three times greater. This is the reason why asset appreciation has so little effect in driving China’s domestic demand or raising internal consumption.

Where Did the Government’s Money Go?

I mentioned above that the government’s fiscal revenue was 5.1 trillion yuan ($770 billion) last year, and state-owned assets and appreciation of land was at least 9 trillion yuan ($1.36 trillion). State-owned enterprises had profits of 1.6 trillion yuan ($240 billion). The government had a total income 15.7 trillion yuan ($2.37 trillion). How was the money spent?

According to former Finance Minister Xie Xuren, in 2007, the Chinese government’s direct spending on people such as healthcare, social security and employment benefits totaled about 600 billion yuan ($90.6 billion). This was equivalent to 15 percent of total expenditures and 2.4 percent of annual GDP. Divided by 1.3 billion people, the per capita of social expenditures was 461 yuan ($69), which is equal to 3 percent of urban residents’ per capita disposable income.

In the United States, government spending on the same three categories in 2015 was about $1.5 trillion, or 61 percent of total federal spending, and 11.5 percent of GDP. The per capita spending was $5,000 when divided by the 300 million U.S. population, and it was equivalent to 18 percent of Americans’ per capita disposable income.

It is not that the Chinese government does not spend money, but that it lacks real oversight of the budget process. The Chinese government tends to waste money on high-profile infrastructure projects and government office buildings, and invests in industries with high resource consumption, high pollution and low job-creation. In addition, this all provides a breeding ground for corruption.

Because in China there is too much asset wealth and income in the hands of the government, it is difficult for the masses of people to earn more and consume more, and for service industries to develop around people’s livelihoods. Thus, where would demand and investment for tertiary industries come from?

Chen Zhiwu is a professor of finance at Yale University. This is an abridged translation of his Chinese-language article posted on the website Aisixiang, and widely republished on the Chinese-language internet.

China’s currency tumbled in offshore trading last week to its lowest level in a month, as traders speculate that further monetary easing may be in store after disappointing economic growth readings last week.

The offshore yuan (CNH) declined to 6.39 per dollar, compared to 6.35 per dollar for the onshore currency (CNY), on Oct. 23. That’s a spread of around 400 basis points, the biggest in more than a month.

CNY represents money traded within China and under its tight currency fix restricted to a 2 percent maximum movement per day. CNH yuan, which trades outside of China and is more free-floating based on supply and demand, is usually viewed as a truer picture of the yuan’s worth.

The existence of this CNH-CNY gap is one of the reasons the International Monetary Fund has been reluctant to include yuan in its currency basket.

While China’s official third-quarter GDP reading of 6.9 percent was higher than expected last week, independent analysis pegs that rate much lower based on consumption and spending figures.

China’s decision to cut interest rates once again last Friday was a smoking gun that the economy may be weaker than reported. The interest rate was cut by 25 basis points, the sixth time the People’s Bank of China (PBOC) has lowered rates in the last year.

China also slashed its banks’ reserve requirement ratio, allowing more credit to enter the economy. The decision was due to increased downward pressure on the nation’s economy, according to a statement on the PBOC’s website.

Removing Rate Cap

Along with rate easing, Beijing also removed rate caps on bank deposits.

This move is an easy one, and helps on two fronts. It lifts the savings rate ordinary households earn on their bank deposits, which increases household wealth.

Two, it can create more competition among Chinese banks, particularly the smaller ones. Higher interest payouts also encourage banks to lend to small and medium-sized businesses, whereas in the past money tended to channel to large, state-owned enterprises.

Currency Devaluation Fears

The latest interest rate cut increased the likelihood that capital flight from China would accelerate as foreign deposits become more attractive.

Last Friday J.P. Morgan analysts estimated that capital outflows during September were between $130 billion to $140 billion. Estimates by Bloomberg, which count dollar holdings by exporters and direct investment recipients, are closer to $194 billion.

Such pressures to sell the yuan, coupled with investor speculation that the PBOC may devalue the currency further in the face of weak economic growth, have sent the yuan tumbling in offshore markets.

Earlier in the month, asset manager PIMCO wrote that it expected further yuan devaluation by the Chinese central bank.

“We expect private capital expenditures and property prices to weaken further, risking a negative spillover to employment and consumer spending. We expect to see a significant monetary policy response from the People’s Bank of China,” PIMCO wrote.

If offshore yuan trading is any indication, a monetary policy response may be imminent.

Over the weekend the first good economic news in a long time came out of China: The country announced official growth figures of 6.9 percent annualized for the third quarter, narrowly beating expectations of 6.8 percent.

The bad news: This number is likely overstated by several percentage points. The caveat this time is a statistical adjustment which uses falling prices to boost growth. Excluding this adjustment, the economy only grew 6.2 percent.

Even that is optimistic: Unofficial growth estimates range from 2 percent to 5 percent. The most reliable indicator, named after Chinese Premier Li Keqiang, blends railway cargo volume, electricity consumption, and new loan disbursement. It shows growth at around 3 percent.

Since the financial crisis of 2008, China has relied on building anything from roads to apartment complexes to generate growth. This investment in fixed assets still made up 46 percent of GDP in 2013 and is now mainly responsible for the slow-down in growth—it grew at only 10.3 percent, the lowest level since 2000.

They want to maintain and semblance of control over their currency, that’s why you see the manipulation.

— PD Shash, PDS Capital Management

“There is still too much steel, iron ore, housing, and copper being produced in that country. The fascinating thing in all of that is you get GDP credit for building a building even if you never sell it,” says Richard Vague, author of “The Next Economic Disaster.”

Although consumption and the service sector (plus 8.4 percent) are picking up, this is likely the tail-end of the construction boom, rather than a new era for the Chinese economy. According to the China Beige Book, which collects on the ground data from thousands of Chinese firms every quarter, services to businesses are actually declining.

“China is reforming and they are going to transition … to a consumer economy. I’ve been hearing that for five years,” said Jim Chanos, principal of the hedge fund Kynikos Associates, who has correctly predicted a Chinese slowdown for some time. “Just saying it doesn’t mean it will happen,” Chanos added, addressing The China Institute in New York on Sept. 22.

The estimate ignores numbers which are either out of date (China hasn’t updated its Balance of Payments data since the first quarter) or hard to interpret, like other investment into China, as well as “net-errors and omissions.”

It also doesn’t factor in currency fluctuations, so the final number could be much lower. But whatever it is, it is still too high for the transition to a consumer economy to be real.

High Risk

If the economy was growing at around 7 percent, Chinese and international investors alike would find many ways to make returns far higher than comparative investments in the West.

Instead, they are seeing ever more risks and are deciding to pull their money out. Previously, investors could easily make a 10 percent return on a fixed income investment, with practically no risk. Defaults were not allowed and the exchange rate was fixed.

Even before the devaluation in August, which added risk for foreign investors, defaults in different sectors started to scare investors. Real estate developer Kaisa Group Holdings for example, did not pay interest on two U.S. dollar bonds on May.

It is limited in what it actually can do domestically.

— Evan Lorenz, Grant’s Interest Rate Observer

The underlying problem, masked by manipulated GDP figures and brought to light by increasing capital outflows is too much debt. It increasingly cannot be serviced, let alone paid back.

“They are using loans to pay interest payments. The primary need and use for new private credit is to fund the interest payments,” says Richard Vague.

Macquarie Group analyzed $3.47 trillion worth of bonds and found that 20 percent of the companies concerned cannot pay the interest on their debt with their operating income, so they have to borrow more to stay afloat.

That’s why investors are pulling the rip cord and there is not much China can do about it.

A breakdown of Chinese bond debt in the commodity sector. Companies above the black line cannot pay their interest with their income. (Macquarie)

Monetary Trilemma

The country is suffering from the so-called monetary trilemma which states you cannot have a stable currency, independent domestic monetary policy, and free capital movement.

China wants to have a stable currency and independent monetary policy while gradually opening its capital account.

“It is limited in what it actually can do domestically. If it did quantitative easing tomorrow, it would dramatically increase the pressure to depreciate, which means they have to sell Treasurys, which would actually take renminbi out of the monetary system. It would be self-defeating,” says Evan Lorenz, an analyst at Grant’s Interest Rate Observer.

He thinks China can enforce some rules to stem illicit capital outflows and do some short term liquidity injections, but that’s all to keep things stable for the moment.

The dollar pressure has never been fixed.

— Jeffrey Snider, Alhambra Investment Partners

“Ultimately they can decide if things get dire enough to abandon the peg and ease dramatically in the domestic economy,” he says, but we are not there yet.

Derivative Intervention

On the contrary, the Chinese regime is pulling every lever to convince the market of the official narrative.

For example, China only had to sell $43 billion of its foreign exchange reserves in September to keep its exchange rate stable, compared to $94 billion in August. But this is just the tip of the iceberg.

“As soon as the September number came out everybody said everything is fine now. There is no way to tell for sure. I wonder how much of that has to do with the [People’s Bank of China] manipulating derivatives. Have they pushed some of that capital flight into the future?” asks Jeffrey Snider of Alhambra Investment Partners.

He thinks the PBOC is just delaying the problem by using banks to take derivative positions to decrease the value of the dollar. He says Brazil has employed a similar strategy, but it didn’t work.

“The dollar pressure has never been fixed. What Brazil did in the summer in 2013 just delayed the effect. They just made it worse,” said Snider.

According to Goldman Sachs, the whole Chinese banking system has sold $120 billion worth of dollars (including derivatives) in September, much larger than the $43 billion of official foreign exchange sales.

“Apparently corporates and households converted a large amount of their renminbi deposits into foreign exchange. Overall, today’s data indicates the outflows might have improved only modestly from August,” Goldman analysts write in a note.

“They want to maintain and semblance of control over their currency, that’s why you see the manipulation,” he says. He gives his target for the offshore renminbi, which closely tracks the mainland currency and can be actively traded [currently 6.37]. “You could see it go up to 6.5 by the end of the year.”